Back in February, I posted an article about the current state of market valuation at that point in time. You can read the article here. Given that we are now 2 months ahead, maybe we should take a quick revisit at where the market valuation is at right now.
As an investor, I think it is prudent knowing what and where the current market valuation is heading as a source of information, even if you do not intend to use them for decision making purpose. I’ve received a few emails in recent weeks asking me whether I’m starting to turn bearish on the stock market. I think the answer to what I think is pretty irrelevant. What is important is knowing and understanding your own position in the market justifying instead of deluding yourself into believing that you are “investing” when you are or actually not.
With that, let’s see if there are any changes to the market valuation from where it were back then in February. I am going to use the same valuation metrics for easy comparison purpose.
1.) Market Capitalization to GDP (Buffett Valuation Indicator)
The market cap to GDP ratio, also dubbed the Buffett valuation indicator, is a long term ratio used to determine whether an overall market conditions is undervalued or overvalued. As the ratio suggests, a result that is greater than 100% is known to be overvalued while a value below 100% is know to be undervalued.
The ratio suggests 123.1% back then in the last quarter, and now it has increased slightly to 127.4% in this quarter. This simply implies that the valuation in this indicator is in bubble territory and the bubble is expanding in this quarter. The ratio is now above +2 SD and this is the first time that it happens over the last 50 years or so, only to be eclipsed by the great bubble in 2000.
2.) Q-Ratio (developed by Nobel Laureate James Tobin)
The Q Ratio is an indicator of the total market value divided by the replacement cost of the overall market. This is a little bit like measuring the Price to Book where the earlier was like the Price to Earnings. Again, anything above 100% represents overvaluation while anything below represents undervaluation.
No changes to this quarter from previous quarter. The current situation represents a ratio of 1.11 which indicates that the market is overvalued in terms of its replacement value, a concept that is almost similar to the book value.
3.) Regression To Trend
The regression trendline drawn through clarifies the secular pattern of a variance from the trend. Where the market is trending above the regression slope, they are known to be overvaluation while the converse is true.
The data shows that the inflation adjusted S&P Index price was 93% above its long term trend, down from 96% we’ve seen in the previous quarter. Nevertheless, there’s no doubt that the trend suggests overvaluation above the long term average mean.
Half-Half Philosophy
In the previous article, I suggested that there may be a hype of speculating from the opening of the new accounts especially in the China and HK market.
Similarly, I’ve also seen many new investors coming into the market at this moment with the intention of investing for the longest term, but because for some reason they’ve landed in the market in the current situation, they have a “tendency need” to invest right now not bothering about timing the market consistently because a lot of proverbs have been saying that no one has the ability to do so.
But contrary, some of the decisions I’ve seen in recent times suggest that these are the same group of people that are not investing consistently based on their own earlier philosophy because they are partly afraid of being caught in the situations of a correction. In other words, these people entered into a position with the intention of holding for a long term but because recent market surge has a potential to earn them a 5% realized gain, they decide to sell first in favor of the gain and redeploy the cash to some other counters, using similar method.
I called this the half-half philosophy because I’ve been caught in the same position many times, and many more so when I first started investing. The thought of investing for the long term seems pretty cool to many investors out there but when there are unrealized gains staring right in front of your screen, it seems pretty foolish not to be locking in those profits when you can.
To me, this is outright speculation and I’ve done it many rounds previously and and even now. Notice just how many times the word price is being mentioned and nothing about the fundamentals of the business or valuation is being mentioned. This strategy is definitely not wrong but just don’t confuse them with investing.
Final Thoughts
In one of the books I’m reading right now in the “Intelligent Investor”, Benjamin Graham defined the difference between investing and speculating this way:
“An Investment Operation is one in which, upon through fundamental analysis, promises the boundary of where valuations are defined, safety of principal is compromised and an adequate return is projected. Operations not meeting these requirements are speculative in nature.”
Most of us are probably grown up to be able to make our own decisions. We can choose to play any strategy or games we like and that is our prerogative rights to do so. But having said that, we should do so with our eyes fully open and knowing the truth of the consequences. That is probably what investing in realities is all about.
B,
This is great data man. I have a bunch of US companies on my watchlist but haven't been able to pull the trigger to buy as the valuations seem high at the moment.
Your article definitely provides a warning/reminder for investors like me who started out in 2010, and never experienced a bear market before.
Although the data shows a danger – the current feel of the market seems very conservative? (Maybe other than the warning signs in China…)
Seems like people are still wary of QE, rise in interest rates, and the memories of GFC are still fresh in their heads?
What are your thoughts on this?
Hi BfGf
No problem, you're welcome 🙂
I think you are well aware of the underlying risk of your own investment, so as long as you have the necessary plans and steps to allow you to do what you have to do, it should be a fine plan over the long run 🙂
I'm in the midst of working out a plan on my asset allocation myself, it'll be a useful plan to have in terms of mitigating psychological factor as well during a market downturn.
Overvalue sounds right, as we are in the bull market since March 2009. I, myself, expecting a correction, but at the sometime, in my 401k account, I'm still 100% in stock. Since I'm unable to touch this money until I quit the job or at 65 years old, even if there is a 10-20% correction! I believe I can still ride this out.
After learning there are a few dips, I did have a strategy to keep 20% cash ( or easy access money ) in my taxable account. 1. I'm relying the money on this account to buy an investment property in the future. 2. Market correction is expected when the interest rate is implement, or Greece situation coming up again.
Hi Vivianne
I've read your blog and plans and I think you are a person with a detailed plan lined up so I won't be too worried about that if I were you. Sticking to the plan and ensuring that we stay focused are an investor's role on top of merely picking out the best stock out there.
Hi B,
It's easy to say you're an investor, but it's hard to be an investor. I think it's more temperament than anything.
That being said, good traders will tend to learn more fundamentals to better their craft. Likewise, good investor will learn about trading to better their crafts. I don't think they are separated by such a big gulf that cannot be crossed.
When the market rises unreasonably, what can we do? We can buy more, sell, short or we can do nothing. I think the first option is the most important. When market rises, do anything but don't buy more.
Hi LP
You are right, a true investor is greatly misrepresented in today's environment and they are much more than just picking out great stocks to invest.
We are all good traders at the times we are proven right, it appears that it's so easy to replicate or extrapolate that over the long run. But being an investor is a totally different play altogether.
That analysis does seem a pretty compelling case that there's not great value in the stock market at the moment. But you have to be careful not to throw away your own investment strategy and sell out because you think it's at a 'peak' (unless of course, that is your investment strategy!).
I've made so many mistakes in the past of selling an 'overvalued' stock, only to see it continue to surge, and never have an opportunity to buy back in. As you said in your opening statement, being aware of the state of the market is important, even if you're not acting on it – but I've had to work hard to avoid making bad decisions on the back of evidence like this in the past! But this analysis might just help you decide how much and how aggressively you want to invest in the stock market.
How do the metrics in your post affect your own investment plan at the moment B?
Hi Jason
You are right, this moment is definitely important for one to keep in mind the strategy we intend to hold and stick to it.
My plan will always be top down from allocating a good number of the asset allocation and from there, I'll stick to the really good companies (I'll be really strict on this) and keep them.